Fortescue - explaining the various cost and price metrics

There are numerous figures floating around on Fortescue and iron ore regarding various prices and costs, which has understandably caused some confusion. Due to frequently asked questions we have formed a basic summary of what the different price and cost metrics mean within the sector

Iron ore production levels (wet vs dry)

Production is usually quoted in terms of wet metric tonnes (wmt), and the iron ore price is based on dry metric tonnes (dmt)

To adjust from wet to dry tonnes, an 8% reduction is applied to the wet tonnes to adjust for moisture content

It’s important to understand whether something is being quoted in ‘dmt’ or ‘wmt’

Iron ore price – index vs realised price

The usually quoted iron ore price seen in the media is based on the index price using a 62% ferrous content (a benchmark measure of the quality of the ore)

The realised price iron miners get for their product is not the index price – their realised price will depend on the relative quality of their product to the index benchmark

Fortescue’s delivered price is adjusted for its quality and lower ferrous content – it has historically been able to sell its product at an 85% discount to the index price

So if the iron ore index price is at US$58/dmt, Fortescue will be realising a price of about US$58 x 85% = US$49.3/dmt on its iron ore

C1 Cost

The C1 cost represents the ‘direct’ production costs of iron ore and is a commonly quoted figure. However, it does not represent the full cost of production. Fortescue’s C1 cost guidance for the second half of FY15 is US$25-26/wmt.

Delivered cost

The delivered cost includes the C1 cost, plus shipping, royalties and overhead costs. Fortescue’s delivered cost guidance for the second half of FY15 is US$35/wmt.

All-in cash cost

The all-in cash cost is the delivered cost, plus interest and sustaining capital expenditure. Fortescue’s all-in cash cost guidance for the second half of FY15 is US$41/wmt. The extra US$6/wmt above delivered cost is made up of interest at US$4/wmt and sustaining capex at US$2/wmt. It’s worth noting that interest is actually a relatively small part (<10%) of Fortescue’s overall cost of production – therefore it’s all-in cash cost is not overly sensitive to changes in its cost of funds.

Free cash flow breakeven price

The free cash flow breakeven price generally means the index price level at which Fortescue is producing at breakeven on an all-in cash basis

To determine the breakeven price, the first step is to adjust the all-in cost from ‘wet’ to ‘dry’ tonnes – so US$41/wmt is equivalent to US$45/dmt

The next step is to gross up by the 85% product discount to get to an breakeven index price - so US$45/dmt / 85% = US$53/dmt which is the often quoted breakeven

Some analysts also make a further adjustment for prepayments. This is where Fortescue has received cash upfront to deliver future tonnages

The relationship between currency and Fortescue’s costs

Fortescue’s 2H15 cost guidance of between US$25-26/wmt assumes an average exchange rate of 0.80

Fortescue's cash costs of production benefit from a weaker Australian dollar – so bondholders get a double benefit from a weaker Australian dollar

The company has guided that every 1c weakening in the currency leads to a US$0.25-0.30 reduction in cash costs

So if the currency is at 0.70, Fortescue’s C1 cost would reduce by about a further US$2.50/wmt below its 2H15 C1 cost guidance of US$25-26/wmt

The relationship between oil prices and Fortescue’s costs

Fuel and energy costs make up approximately 12% of total C1 costs

Lower oil prices reduced C1 costs by approximately US$0.26/wmt in the December 2014 quarter.

Fuel and energy costs also have a significant impact on the cost of shipping which averaged US$8.50/wmt in the December 2014 quarter

For more information on Fortescue or the securities on offer you can contact your FIIG Representative

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